Educational Articles

Stock Screen: Highest PE Ratios – April 4, 2011

Lester Ratcliff
| April 04, 2011

Although mathematically simple, taking a company’s price and dividing it by its earnings can tell an investor a great deal. The P/E ratio, as it is called, shows how much investors are willing to pay for a dollar of earnings. So, if a company has a stock price of $20 and earnings of $1.00, its P/E would be 20. Each dollar of earnings is worth $1 to the market. If that same company trading at $20 per share earned $0.50, however, the P/E would be 40—investors would be paying $2.00 for each dollar of earnings.

The price to earnings ratio is a valuation metric, helping to decipher if a stock is expensive or cheap. Although some use absolute metrics (a P/E over 20 is expensive, for example), P/E is most useful on a relative basis, comparing one company to its historical trends, to another company, or to an industry or market average. It is a way to measure that voting machine mentality of Wall Street about which Benjamin Graham wrote. The thought is that growth and momentum investors are willing to pay more for a dollar of today’s earnings to invest in a quickly growing company. A value investor, meanwhile, would prefer to wait until a company is “on sale” and trading at a low P/E multiple.

Every week Value Line publishes screens of the highest and lowest P/E ratios in the Index section of The Value Line Investment Survey. Although the common refrain is that value seekers should focus on the lowest P/E screen and growth and momentum investors should focus on companies with higher P/Es, this isn’t always true. The high P/E screen often turns up companies in the midst of a turnaround. So, while growth and momentum investors may find quickly growing companies on the high P/E list, value investors willing to sort through the 100 names can also find some hidden gems.

WebMD Health finished 2010 in fine shape. The top line remained on the advance, reflecting good growth in advertising and sponsorship revenue from its public portals. The operating leverage in the company’s business model was also evident, as profit margins continued to expand and share earnings moved forward at a quick pace.

Ad and sponsorship revenue from the company’s public portals should continue growing rapidly in 2011. Indeed, companies hailing from the drug, biotech, and consumer packaged goods industries find WebMD’s sites attractive, given their audience (which is effectively self-selected and interested in health-related information), and are likely to continue moving a portion of their ad budgets from traditional venues to the online arena. Moreover, the company is working to extend its reach into the digital world by moving into the mobile space. The move to mobile seems to have already been successful with professionals (Medscape.com), and our sense is that the consumer end is likely to catch on soon. Meanwhile, WebMD keeps abreast of its users’ interests and tailors information categories accordingly, thus keeping its sites’ content current and protecting the value to advertisers.

WebMD’s profit margins should continue to widen, benefiting from the large operating leverage in this business. And our sense is that the ability to leverage expenses will be a feature of WebMD’s business for some time yet. There are also opportunities in international markets. In sum, WebMD may have considerable appeal to growth and momentum investors.

Baidu, Inc.
Baidu, Inc. is a Chinese-language Internet search provider. The company principally operates through its Baidu Online Network Technology Co. Ltd. located in Beijing, China. It also provides online advertising services through Baidu Netcom Science Technology Co. Ltd. The company also runs a Japanese search service at www.baidu.jp.

Baidu logged impressive financial results for 2010. Revenues advanced roughly 84% on a year-to-year basis due to increased traffic and rapid growth in spending from the online retail sector. Meanwhile, margins continued to widen, which resulted in share net increasing about 2.4 times, to $1.54.

Several new and updated offerings should drive site traffic. For example, Aladdin, which is Baidu’s open data platform, has been improved, and that open application library now has more than 2,700 applications available. These include games, books, tools, and a host of entertainment options. Meantime, Baidu Wenku has over 17 million documents included in its sharing feature. And Baidu Knows is a leading question and answer platform. Baidu Encyclopedia and a mobile version of Baidu Maps round out the lineup.

Online marketing revenues ought to benefit from growth in the number of active online marketing customers, as well as from higher revenue per customer. Both of those measures advanced by double-digit percentages last year, and we look for those trends to continue. Despite the company’s solid past performance, only a relatively small portion of China’s businesses are utilizing search engine marketing (SEM). Baidu has a qualification program in place to further promote SEM and train online marketing professionals, which may help it tap into those markets. Elsewhere, traffic acquisition and bandwidth costs have been on the decline as a percentage of revenues. Overall, Baidu appears to be well positioned to continue its trend of attractive profit growth.

Bassett Furniture
Bassett Furniture Industries, Inc. manufactures, sells, and imports a wide range of bedroom, dining room, and living room furniture. The company also makes various lines of occasional chairs, tables, wall units, and upholstered furniture. The company sells its products at both the wholesale and retail level through a network of 68 licensee-owned stores and 36 company-owned stores.

Bassett Furniture probably incurred a loss in the fiscal first quarter (ended
February 25, 2011). Escalating sociopolitical turmoil abroad and global inflationary triggers have increased oil and metals prices. These challenges likely placed a damper on consumer spending toward the end of the interval and weighed heavily on the gross margin due to higher freight and manufacturing costs.

Nonetheless, the company is making strides toward profitability. The residential furniture manufacturer is trimming its losses during difficult periods, including the seasonally weak fiscal first quarter. Bassett had benefited, until recent weeks, from much improved economic conditions and a stronger retail environment. We believe that both wholesale orders and retail traffic will continue to rise this year. Backlog is building, and recently implemented promotional programs and marketing initiatives have begun to pay off, as volumes of newly introduced products have been picking up. In addition, efforts to increase the number of company owned stores, coupled with measures aimed at enhancing operational efficiency at those locations, have paid off. This has been demonstrated by narrowing losses in the retail segment. Although commodity inflation will probably remain a concern as the economy recovers further, underlying demand should continue to strengthen and drive improved sales and profits.

Given the recent climate, Bassett’s efforts to reduce its cost structure will be crucial for profitability. We expect the company to maintain its cost discipline and seek out savings wherever possible. Therefore, plant consolidations and divestitures of underperforming assets are likely. In summary, Bassett Furniture appears to be a possible turnaround play that might appeal to speculative investors.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.